Hong Leong Finance - DBS Research 2017-08-10: Stellar Earnings Recovery

Hong Leong Finance - DBS Vickers 2017-08-10: Stellar Earnings Recovery HONG LEONG FINANCE LIMITED S41.SI

Hong Leong Finance - Stellar Earnings Recovery

  • Hong Leong Finance's 2Q17 bottom line posted stellar 89% y-o-y/ 27% q-o-q growth.
  • High growth in fee and commission income (+44.5% yo-y), lower cost of funds, staff costs, provisions were key positives.
  • Await implementation of changes to Finance Company regulations.
  • Interim dividend of 4 Scts declared (2016A: 3 Scts); expect FY17F dividend yield of 4.3%, maintain BUY with TP S$3.20.


New opportunities abound; M&A potential. 

  • MAS’ rule relaxation on finance companies (fincos) in mid-Feb 2017, which lifted the limits on uncollateralised loans as a percentage of capital funds (from 10% to 25% of capital funds) and liberalised its existing policy to allow a foreign takeover of a finco (subject to certain conditions), opens new opportunities for Singapore fincos. 
  • Hong Leong Finance (HLF), the largest of the three fincos in Singapore, is poised to benefit.


Strong earnings recovery, expect FY17F dividend yield of 4.3%.

  • 2Q17 earnings grew strongly by 89.1% y-o-y/26.8% q-o-q, primarily aided by high growth in fee and commission income (+44.5% y-o-y), lower cost of funds due to low fixed deposit rates in Singapore, and lower staff costs and provisions. 
  • For 1H17, HLF recorded 45.9% growth in bottom line. We expect HLF to pay ~11.5 Scts dividend for FY2017, which represents dividend yield of 4.37% at last close price of S$2.63.


Where we differ. We are the only broker covering the stock.

  • Post MAS’ rule relaxation, all three fincos have re-rated to price in a possibility of M&A. However, we believe HLF’s current share price has yet to price in this year’s earnings recovery, as well as its strength as the largest finco in Singapore.


Potential catalyst. 

  • Further relaxation of funding and lending rules, as well as M&A newsflow are potential catalysts for stock price re-rating.


Valuation: TP of S$3.20, maintain BUY. 

  • Our TP of S$3.20 offers 22% upside potential, and is derived from the Gordon Growth Model with 5.1% ROE, 1.5% long-term growth and 5.8% cost of equity, implying c.0.8x FY17F BV. 
  • Under a M&A scenario, we believe HLF should attract a minimum 1x BV (~S$3.80 as current shareholders are unlikely to sell out at lower valuations given its strong prospects under this new regulatory regime; this implies there is a minimum potential upside of c.40% over last close of S$2.63.


Key Risks to Our View

  • As a smaller financial institution, and with exposure to riskier business lending, HLF may be more prone to asset-quality upsets should the economic cycle deteriorate. 
  • Also, HLF is more sensitive to changes in fixed deposits rate, in contrast to banks who have a large CASA base.


WHAT’S NEW


Stellar earnings growth in 2Q17.  89.1% y-o-y/ 26.8% q-o-q growth in bottom line.  

  • HLF recorded stellar earnings growth of 89.1% y-o-y/ 26.8% q-oq in 2Q17 of S$20.9m. On a q-o-q basis, earnings growth was primarily driven by lower cost of funds (-13.4%) and higher fee and commission income (+11.4%). 
  • On a y-o-y basis, lower costs of funds (-30.2%), higher fee and commission income (+30.8%) and lower staff costs (-6%) were offset by a decline in interest income. 
  • For 1H17, HLF saw 45.9% growth in bottom line.

Higher interest income q-o-q encouraging. 

  • 2Q17 posted 2.2% q-o-q increase in interest income to S$73.7m from increase in interest on loans and hiring charges, compared to the decline registered in 1Q17, which was encouraging. 
  • On a y-o-y basis, decrease in interest income was mainly due to a drop in loan base and a lower loan yield.

Strong growth in fee and commission income. 

  • Strong growth of 30.8% y-o-y/11.4% q-o-q in fee and commission income (S$4.1m) was driven by both lending and non-lending products, helping to offset the impact from lower interest income.

Lower provisions. 

  • Provisions decreased from S$1.9m in 2Q16 to S$0.7m in 2Q17. For 1H17, there was a small provision write-back of 


Outlook 


Poised to benefit from lower interest expense. 

  • We believe that HLF is set to benefit from lower interest expense, as a large portion of the fixed deposit cost for the year has been locked in. 

Loan growth outlook flat YTD, likely to have bottomed. 

  • Loan growth was flattish, at +0.4% higher YTD. We remain positive that loan contraction has bottomed out as loan book remained largely flat q-o-q after seeing a contraction through FY2016. 
  • We believe that loan growth is set for recovery against better economic conditions with encouraging signs of an improving property market and GDP outlook. 

Expect higher dividend for full year. 

  • Interim dividends of 4 Scts was declared (2016A interim dividend: 3 Scts). HLF’s dividend payout ratio has been ~67% for FY2015A and FY2016A, and higher in previous years. 
  • Assuming a 67% dividend payout ratio for this year, we are expecting ~11.5 dividend for the full year (~7.5 Scts final dividend on top of 4 Scts interim dividend declared) based on our earnings estimate, which brings dividend yield to 4.37% for the full year at last closing price of S$2.63. 

Await implementation of changes to Finance Company regulations. 

  • MAS announced various changes in 1Q17. HLF is currently awaiting implementation of these changes, which is likely to come in 2H17. 

Seeking ways to collaborate with FinTechs. 

  • HLF is seeking ways to collaborate with FinTechs as HLF recoginses that FinTechs can bring about process simplification and improvement, as well as deliver a more technologically driven customer experience for the younger generation. 
  • We expect any collaboration to be a plus for HLF, potentially improving processes and driving down costs. 




Sue Lin LIM DBS Vickers | Singapore Research DBS Vickers | http://www.dbsvickers.com/ 2017-08-10
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 3.200 Same 3.200



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